Monday, 25 April 2011

Japan's earthquake must force JIT supply changes

It is, perhaps, ironic that the first country to adopt Just-in-Time (JIT) supply techniques avidly should now be the cause of a rethink on JIT global supply chain deliveries that could leave Japan worse off.

JIT supply issues have done much to cut costs by reducing inventories at every level of the supply chain. The West's outsourcing of much production to Far Eastern countries, particularly China, has also raised living standards of their peoples sharply and helped western countries keep a lid on their inflation through cheaper imports. As a technique, therefore, JIT is here to stay but as the Japanese quake and tsunami of March 11 clearly showed, many supply chains have become too rigid and wedded to outsourcing components to low-labour cost countries prone to high earthquake risks, floods and typhoons. "In many cases, tightly stretched global supply chains do not make sense any more," said Robert Martichenko, chief executive of Leancor, a US logistics company.

In my blog of April 23, 2010, headed: " Has volcanic ash lessons for logistics?" which touched on the supply chain effects of the Icelandic volcanic eruption, I warned that "vulnerability to disruption must be reduced." That disruption was on a far lower scale than last month's Japanese quake but big enough to spur a JIT rethink. But it is clear that many companies have failed to put in place back-up plans to cope with emergencies like the Japanese catastrophe. They were content to place all their eggs in one basket like Japan or China owing to low production costs while ignoring the obvious risks of natural disasters. But even where companies had a disaster-recovery plan in place, room for manoeuvre depends largely on the nature of the industry. What use, for example, is a disaster-recovery plan if parts cannot be duplicated outside of Japan, as is the case with parts for Boeing jets?

The degree of dependence on Japan for critical parts is alarming. Japanese factories produce about 40% of the world's electronic components and Hitachi Chemical has 70% of the global market for a type of slurry used by chipmakers to polish wafers, and its plant was damaged by the tsunami. In China, mainly in Guangdong province, 80% of the world's basic electronics components production, along with a great deal of final assembly, shows the potential for disruption here to affect global industries. In such industries there are few opportunities to mitigate the consequences of severe natural disasters in south-eastern China.

The March 11 quake and resultant tsunami expose the over reliance on one source of component supply. The costs, this time around, are so huge that, hopefully, some lessons will be learned and acted upon. Japan's earthquake and tsunami are estimated to have cost the three big Japanese car makers at least a $1 billion hit to profits. One consultancy estimates that the tsunami-related disruption will cut worldwide light vehicle output by 2.7 million vehicles in this year's second quarter of which one million will be in Japan and 475,000 each in North America and Europe. In Britain, Toyota was the third car company to announce production cuts owing to the Japanese quake. Toyota's plants in France, Turkey and Poland will also be subject to cutbacks.

In time, rising production costs in China will favour a shift of production back to countries concerned to have a more secure source of supply unaffected by natural disasters. There are, however, other reasons favouring a production shift back to regions close to their markets, like flexibility to react to market changes more responsively. This process has already begun but it is not to argue that countries like China and Japan should be eschewed entirely as a manufacturing base for components. Rather, China and Japan should be considered as only one of several supply sources so that disruption in one country can quickly be compensated by production ramp ups elsewhere . This will require key investment in more geologically and climatically favourable countries.

The problem for many global corporations is that they are mesmerised by cheap production costs in disaster-prone countries. They know the natural disaster risks but feel that their infrequent occurrences on a major scale justifies the risks. But the past record of natural disasters is no guide to future trends and so, hopefully, the Japanese quake last month will be a wake up call for greater diversity of supply. Nature, is should be added is not the only threat to the supply chain. There are also significant political risks.

Uneasy though it is for me to assume Cassandra's role, I have strong feeling that a natural disaster, be it seismic or flooding, will slam south-east China within months, despite this area's
relatively low seismic activity. The last serious quake to strike Guangdong was in 1918, leaving around 1,000 dead. Another severe quake here could, perhaps, test the global supply chain in some products to almost breaking point, unless companies act now.

It is a tragedy that when history is ignored it becomes as dust-laden garbage. It becomes far greater and crasser tragedy still when it is deliberately ignored for commercial expediency. History, after all, can bight back.

Tuesday, 5 April 2011

Bank of England's hidden agenda guts all savers

There can now be no doubt that the Bank of England (BoE) has abandoned all pretence of controlling inflation through the interest rate mechanism, once considered its core function since its independence over 10 years ago. And like America's Federal Reserve Bank, it is now trying to serve two masters, despite the Nazarene's missive on such futility. On the one hand the BoE still professes to want to curb inflation but on the other it keeps interest rates at historically low levels ostensibly to help the nascent recovery and so bring down unemployment. But in pursuing the first objective through ludicrously low interest rates it merely risks a re-run of the credit mess following the bust and 9/11 which created crassly low interest rates and so unleashed a spending binge fueled by cheap, lax credit. The BoE's anti-inflationary policy has failed lamentably, though in fairness partly because of circumstances beyond its control. Its monetary policy committee is required to achieve a target of 2% inflation. The latest retail price index for February 2011 shows an annual rise of 5.5% while the Government's own preferred benchmark, the consumer price index, has soared by 4.4% over the same period. But is the BoE's low interest rate policy to encourage recovery a smokescreen for a more cynical ploy that will have unprecedented adverse impacts on pensioners and all those who saved hard for their old age? The numbers suggest that it is. "Banking establishments are more dangerous than standing armies," commented Thomas Jefferson. How right he was but in ways, perhaps, that even he did not realise. Such an ostensibly august institution like the BoE was, in fact, born out of the perceived necessity to finance war. With the power to create credit up to 12 times the cash deposits placed with it, the BoE used debt to finance the British Government's wars throughout the 18th century until the national debt soared to over 200% of gross domestic product (GDP) at the end of the Napoleonic wars in 1815. Such a debt level was not seen again until World War 2, while today it stands at 60% of GDP, a level not seen since the late 1960s. Debt, it seems, is the Devil's chaplain. Clearly, debt has some advantages. It can, for example, facilitate economic growth and allow consumers to have their desires fulfilled now rather than years down the line when they have saved enough to buy goods outright. The flip side on runaway debt levels, however, has disastrous potential. It is the BoE's hope, and probably the Government's, that by keeping interest rates absurdly low it will encourage business investment and private consumer spending. But will it? Compared with collectivist economies, capitalism's one great disadvantage is that the decisions to invest and the decisions to spend are taken by two different groups. Capitalist economies can encourage investment through government incentives like lower taxes and low interest rates, but it cannot force the public to spend more as as result. The risks that the current BoE and Government's policy may fail in their pump-priming objective are high because the huge debt levels taken on by government now mean public spending must be drastically cut and many workers fear for their jobs and when fear stalks the land the public's propensity to save rises. Business will not invest much more if they see a public spending less. Meanwhile, the dangerously low interest rate policy has other recovery impediments. It takes four to five building society investors to support one mortgage borrower. While borrowers benefit from low interest rates and so may be inclined to spend more, the savers supporting them all suffer real falls in their disposable incomes because inflation and tax now far exceed investors' derisory returns of 3% or less. It is, perhaps, the BoE's greatest, most shameful transfer of wealth from the frugal to borrowers. But there is seemingly worse behaviour afoot. The UK government's debt for 2011 is estimated at £932 billion, or 60% of GDP. Its spending on state pensions will be £117 billion this year and while that may be indexed to the retail price index for annual rises it is clear that by keeping interest rates low the BoE will make it much easier for the government to repay its huge debts through depreciated money. At 5% inflation the Government's national debt would be cut by £51 billion in real terms after one year. The extra costs of the state pension in money terms would be only £5.85 billion over the same period. The case for continuing the low interest rate policy is unsustainable and grossly iniquitous on those least able to defend themselves -- the pensioners and small savers. If rates were allowed to rise to their long-term levels of 5% or 6% it would encourage the retired, in particular, to spend more and these far outnumber mortgagees who would be faced with spending less. Higher rates would also head off the reckless spending by investment banks, hedge funds and other pinstripe bookies which dreamt up new investment packages like collateralized debt obligations and credit default swaps, which together with derisory interest rates largely caused the worst credit implosion since the 1930s. There is, however, another lesson the British Government, in particular, must learn. The Chinese sage, Sun Tzu, remarked in 400 BC : "Where the army is prices are high. When prices rise the wealth of the people is exhausted." With Afghanistan costing the British tax payers well over £6 billion a year, Libya at least £3 million a day, with the potential for far more, and military spending commitments like two unnecessary aircraft carriers and the Trident submarine replacement cost looming on the horizon, such events can only be inflationary. When America grappled with the rocketing inflationary consequences of the Vietnam war in the 1970s it led to Federal fund rates hitting 20% and soaring unemployment to get the situation back under control. The message from the Fed was that unemployment had to take a back seat to fighting inflation. It is a lesson that thus far seems to have been lost on the BoE. Now is the time to raise rates significantly before it is too late.